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What Is PMI and How Can You Avoid It?

ByWallstreet Observer

Quick answer

  • PMI is Private Mortgage Insurance, a fee protecting lenders if you default on your mortgage.
  • It’s typically required for conventional loans when your down payment is less than 20% of the home’s purchase price.
  • You can often avoid PMI by making a larger down payment.
  • Another way to avoid PMI is to seek out “lender-paid PMI” options, though this usually means a higher interest rate.
  • You can also request to cancel PMI once your loan-to-value ratio reaches 80% or when you reach 78% automatically.
  • Refinancing your mortgage can sometimes eliminate PMI if you have enough equity.

Who this is for

  • First-time homebuyers who are considering a conventional mortgage with a down payment under 20%.
  • Homeowners who currently pay PMI and want to understand how to get rid of it.
  • Individuals looking to understand the costs associated with lower down payment mortgages.

What to check first (before you act)

Goal and timeline

  • What to check: Clearly define why you want to avoid PMI. Is it to save money monthly, or to reach homeownership faster with a smaller down payment? What’s your timeframe for achieving this goal?
  • What “good” looks like: You have a clear understanding of the financial benefits of avoiding PMI and a realistic timeline for your homeownership goals.
  • Common mistake: Not having a clear goal. This can lead to making decisions that don’t align with your long-term financial well-being. For example, stretching your budget too thin just to avoid PMI might lead to financial stress later.

Current cash flow

  • What to check: Analyze your monthly income and expenses. How much extra money can you comfortably allocate towards your mortgage payment or savings each month?
  • What “good” looks like: You have a detailed understanding of your monthly budget and can identify surplus funds that could be used for a larger down payment or to pay down debt faster.
  • Common mistake: Underestimating your expenses or overestimating your income. This can lead to an inability to save for a larger down payment or a struggle to make your mortgage payments, potentially negating any savings from avoiding PMI.

Emergency fund or safety buffer

  • What to check: Do you have an emergency fund covering 3-6 months of essential living expenses? This is crucial before committing to a larger down payment or taking on a higher mortgage payment.
  • What “good” looks like: You have a dedicated emergency fund that provides a safety net for unexpected events like job loss or medical bills.
  • Common mistake: Depleting your emergency fund to make a larger down payment. While it might seem like a way to avoid PMI, it leaves you vulnerable to financial emergencies, which can be far more costly in the long run.

Debt and interest rates

  • What to check: List all your outstanding debts, including credit cards, auto loans, and student loans, along with their interest rates. High-interest debt should often be prioritized.
  • What “good” looks like: You have a clear picture of your debt obligations and their associated interest rates, allowing you to strategically decide where to allocate extra funds.
  • Common mistake: Focusing solely on avoiding PMI without addressing high-interest debt. Paying off a credit card with a 20% APR will likely save you more money than avoiding PMI on a mortgage.

Credit impact

  • What to check: Review your credit reports and scores. A good credit score is essential for securing favorable mortgage terms and potentially avoiding PMI altogether.
  • What “good” looks like: You have a strong credit history and score, which can open doors to better loan options and may even allow you to negotiate PMI out of your loan earlier.
  • Common mistake: Not checking your credit before applying for a mortgage. Negative surprises on your credit report can lead to higher interest rates or even denial of your loan, impacting your ability to buy a home or avoid PMI.

Step-by-step (simple workflow)

1. Determine your loan-to-value (LTV) ratio

  • What to do: Calculate your LTV by dividing the loan amount by the home’s appraised value. For example, if you borrow $200,000 for a $250,000 home, your LTV is 80% ($200,000 / $250,000).
  • What “good” looks like: You understand the current LTV of your mortgage, which is key to knowing if PMI is required or if you can cancel it.
  • Common mistake: Assuming your LTV is fixed. It changes as you pay down the principal and as your home’s value fluctuates.

2. Understand your mortgage terms

  • What to do: Review your mortgage agreement to see if PMI is included and under what conditions it applies.
  • What “good” looks like: You know the exact terms of your mortgage, including any PMI requirements and the conditions for its cancellation.
  • Common mistake: Not reading the fine print of your mortgage documents. This can lead to unexpected fees and a lack of clarity on how to proceed.

3. Aim for a 20% down payment

  • What to do: If you’re buying a home, try to save enough for a 20% down payment to avoid PMI from the start.
  • What “good” looks like: You can afford a 20% down payment, eliminating the need for PMI on your conventional loan.
  • Common mistake: Rushing to buy a home and making a smaller down payment than you can afford, thus incurring PMI unnecessarily.

4. Explore “no PMI” loan options

  • What to do: Ask lenders about loan programs that don’t require PMI, such as certain FHA loans (though these have their own mortgage insurance premiums) or specific conventional loan products.
  • What “good” looks like: You’ve identified and qualified for a loan that doesn’t require PMI, either through a larger down payment or a specialized program.
  • Common mistake: Assuming all loans with less than 20% down require PMI. Some lenders offer alternatives.

5. Consider lender-paid PMI (LPMI)

  • What to do: Discuss LPMI options with your lender. This is where the lender pays for your PMI, but you’ll typically have a slightly higher interest rate on your mortgage.
  • What “good” looks like: You’ve weighed the pros and cons of LPMI and determined it’s a suitable option for your financial situation, potentially offering a lower upfront monthly payment than borrower-paid PMI.
  • Common mistake: Not understanding that LPMI often means paying more in interest over the life of the loan, even if the monthly payment is lower initially.

6. Make extra principal payments

  • What to do: If you have PMI and can afford it, make extra payments specifically towards the principal balance of your mortgage. Ensure these extra payments are applied to the principal, not just prepaid interest.
  • What “good” looks like: Your extra principal payments are effectively reducing your loan balance, bringing you closer to the LTV threshold for PMI cancellation.
  • Common mistake: Paying extra without specifying it’s for principal. Some lenders might apply it to future interest payments or escrows, not reducing your principal balance as intended.

7. Track your LTV for cancellation

  • What to do: Monitor your home’s value and your mortgage balance. Once your LTV drops to 80%, you can request PMI cancellation. It will automatically cancel at 78%.
  • What “good” looks like: You are actively tracking your progress towards the 80% LTV threshold and are ready to formally request PMI cancellation.
  • Common mistake: Forgetting to request cancellation at 80% LTV. The lender won’t automatically remove it until 78% LTV, meaning you might pay PMI for longer than necessary.

8. Consider a home appraisal

  • What to do: If you believe your home’s value has increased significantly since you purchased it, you may be able to get a new appraisal. If the appraisal shows your LTV is below 80%, you can use this to request PMI cancellation.
  • What “good” looks like: A recent appraisal confirms your home’s value has increased enough to bring your LTV below 80%, allowing for earlier PMI removal.
  • Common mistake: Paying for an appraisal without confirming with your lender that they will accept it for PMI cancellation purposes.

9. Explore refinancing

  • What to do: If you have built significant equity in your home and your credit is strong, consider refinancing your mortgage. A new loan with a lower LTV might eliminate PMI.
  • What “good” looks like: You’ve successfully refinanced your mortgage with a new loan that doesn’t require PMI, potentially securing a lower interest rate as well.
  • Common mistake: Refinancing without calculating all the associated closing costs. These costs can sometimes outweigh the savings from eliminating PMI, especially in the short term.

Common mistakes (and what happens if you ignore them)

| Mistake | What it causes | Fix

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